The good news in emerging-market corporate debt

RyanWibberley

Any investor worried about the fiscal cliff or fretting about the sovereign debt of failing European countries should take comfort in the fact that it is not all doom and gloom.

For those in search of a silver lining, we give you the undiscovered world of emerging-markets corporate debt. Now you may be thinking, "I'm already investing in emerging markets." But this is different. We see that U.S. investors, on average, are investing approximately 2%-3% of their portfolio in EM stocks and almost no allocation to EM corporate debt.

Most of the developed economy's real gross domestic product (GDP) is still below the levels experienced in 2007, while the emerging economies have increased over 20% during that same period of time. It is our opinion that investors are missing out on these opportunities, with low or no allocation to EM corporate bonds.

The EM corporate-debt space is where the largest opportunities exist for investors to gain excess return, where the yields tend to be higher than U.S. corporate bonds and lower debt levels with relatively solid credit quality given its low debt:GDP ratios.

Historically, sovereign debt has been the main focus for investors seeking exposure to global bonds, but that universe of bonds seems to be shrinking compared to the market value of corporate debt.

EM debt has come a long way since the 1990s when the market value of EM corporate debt was approximately 20% that of sovereign debt. Jump forward to 2012, and the market value of dollar-denominated corporate debt is twice that of sovereign debt. Based on these statistics, you would think that everyone would be in this space, but it still is very much under the radar for most U.S. investors.

It would be natural for investors to fret about increased default risk with EM corporate bonds, but the risks may not be as great as one might think. With the globalization of our economies, the more established corporations rely on the financial infrastructure and reporting requirements of U.S. companies. It is very common for EM corporate debt to be issued in U.S. dollars and have bondholder protections that are backed by hard assets or personal guarantees by the owners, which is very good when compared to U.S. bondholder protections.

The crisis in Europe has many investors concerned about an increased default risk in global bonds. Most investors likely assume that emerging-market bonds would be in a worse situation, but we believe the opposite is true. Many emerging economies are in much better fiscal shape than economies in developed countries with emerging-market debt maturing into a more diverse market.

Investors can invest in this area via exchange-traded funds (ETFs) which helps avoid liquidity issues that individual EM corporate bonds may have. Examples of ETFs like this include SPDR BofA Merrill Lynch Emerging Markets Corporate Bond ETF (EMCD), WisdomTree Emerging Markets Corporate Bond ETF (EMCB) and iShares Emerging Markets Corporate Bond ETF (CEMB). Most of the underlying bonds are IG quality and when you combine this with the fact that EM countries have smaller deficits and lower debt than its developed counterparts, ETFs are fiscally sound for the investor.

There are an increasing number of portfolio managers in the mutual fund space who are focusing on this asset class, and this is a great way to gain exposure to the world of emerging-market corporate debt.

The information in this article does not constitute a recommendation to buy or sell any specific security. CIC Wealth Management recommends that you consult with your financial advisor prior to making any investment decision.

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